Chapter 8

Natural Rate of Unemployment

The normal, background level of unemployment that exists even when the economy is doing well. It's the rate the economy gravitates toward over time, and actual unemployment fluctuates above and below it.

Labor Force (L)

Everyone who is either working or actively looking for work. It does not include people who have stopped searching.

Employed (E)

Workers who currently have jobs.

Unemployed (U)

Workers who don't have jobs but are actively looking for one.

Unemployment Rate (U/L)

The fraction of the labor force that is without a job, expressed as a percentage.

Rate of Job Separation (s)

The fraction of employed workers who lose or leave their jobs in a given period. A higher rate means more people are falling into unemployment.

Rate of Job Finding (f)

The fraction of unemployed workers who find a job in a given period. A higher rate means people are getting back to work faster.

Steady State (Labor Market)

The condition where the unemployment rate is stable — the number of people losing jobs equals the number finding jobs. Mathematically: s × E = f × U.

Natural Rate Formula

U/L = s / (s + f). This tells you that unemployment is higher when it's easy to lose a job (high s) and harder to find one (low f).

Frictional Unemployment

Unemployment that happens simply because it takes time to match workers with jobs. Even in a healthy economy, people are always switching jobs or entering the workforce, so some frictional unemployment always exists.

Sectoral Shifts

When demand moves from one industry to another (e.g., from manufacturing to tech), workers in the shrinking industry need time to retrain and relocate, causing frictional unemployment.

Structural Unemployment

Unemployment caused by wages being stuck above the level where supply meets demand. Because wages won't fall, there aren't enough jobs for everyone who wants one, so firms ration positions.

Wage Rigidity

The tendency of wages to stay above their market-clearing level instead of falling when there's a surplus of workers. This is a key cause of structural unemployment.

Minimum Wage

A government-set floor on how low wages can go. When it's above the equilibrium wage — especially for low-skill workers — it can cause unemployment because employers hire fewer people.

Labor Unions

Organizations of workers that negotiate for higher wages. When union wages exceed equilibrium wages, unemployment results. Employed union members (insiders) benefit, while unemployed non-union workers (outsiders) are left out.

Insiders

Employed union workers who use their collective power to keep wages high, even if it means fewer jobs overall.

Outsiders

Unemployed, non-union workers who would prefer lower wages if it meant more jobs were available.

Efficiency Wages

Wages that firms voluntarily pay above market equilibrium because higher pay boosts worker productivity, reduces turnover, and attracts better candidates. This also contributes to structural unemployment.

Unemployment Insurance (UI)

A government program that pays unemployed workers a portion of their previous wage for a limited time. It raises frictional unemployment by reducing the urgency to find a new job quickly, but it can lead to better job matches.

Discouraged Workers

People who have given up looking for work after repeated failures and are no longer counted as part of the labor force. They're not officially "unemployed" even though they want jobs.

Marginally Attached Workers

People who are not in the labor force but want work, are available, and have looked for a job at some point — just not recently. Discouraged workers are a subset of this group.

U-3

The official unemployment rate: total unemployed as a percent of the civilian labor force.

U-6

The broadest measure of unemployment — includes the officially unemployed, marginally attached workers, and people working part-time who want full-time work. It gives the fullest picture of labor market distress.